Even the creator of the 401(k) admits it is a “monster”. Despite my employer’s 6% match, I stopped contributing over 3 years ago and I have not looked back. The main reasons were: performance, control, risk and fees.
Why the 401(k) fails most people
401(k)s come with HIGH fee structures that eat into your compounding. A fee of 0.5% could reduce the value of your portfolio by up to 15% over 30 years!
You are locked in to a provider, bringing counterparty risk and little motivation for providers to design a superior product! In fact, the more you forget about your 401(k), the happier they are. There’s about $2.1 TRILLION of abandoned capital locked in 401(k) accounts merely benefiting the financial institutions collecting fees.
Taxes. You might not pay taxes on it today, but do you believe taxes will be lower in the future?
From this perspective, 401(k)s are among the worst designed products in the market. Cue, alternative approach!
The income stacking strategy alternative
Initially pioneered as an evolution of the debt snowball method, used to pay off debts. It simply extends that concept into investing.
Income stacking means using short-term borrowed capital to buy cash-flowing investments, then using that cash flow — plus what you were already saving — to rapidly repay the debt. When the debt is gone, you keep the investment.
The type of credit, type of investments and available monthly savings all play a part in the exact numbers to use to get started.
How does this connect to 401(k)s? If you take the amount of money you were putting in your 401(k) and put it into relatively conservative investments in this strategy, you create higher returns, with greater control and liquidity over your money, all while building a system that educates you and grows over time.
In my case, I went from a $10,000 initial investment to being able to deploy $50,000 2-3 times a year in 3 years!
Ultimately, if executed well, you can reach "escape velocity" in 5-10 years.
Escape from what? - Escape from the rat race.
A quick illustration.
Let's say you were putting $2,000 monthly into your 401(k).
Now you take out a line of credit for $10,000 and a 10% interest rate. Invest it in a 3-year amortized loan (for example a personal loan) that pays out $315 per month. This is equal to about an 8% APY. To keep things simple, let’s ignore the cost of credit for now.
Month 1, you pay $2,000 of your line of credit back with your monthly savings. And you use the $315 as well. Your balance on the line of credit is therefore $7,685.
Month 2, repeat the payment pattern, paying the line of credit down with $2,315. The balance goes down to $5370.
Month 3 and 4 follow the same pattern. The line of credit stands at $740.
Month 5 gets interesting. You pay off the remaining balance of $740. That means that your line of credit balance is now $0. You also have $1,575 remaining of your monthly $2,315.
How much did this cost?
The cost for your credit in month 1 was $83.
The cost for the credit was $64 in the second month, due to the lower balance.
The same math leads to a final total cost of the line of credit of $83 + $64 + $45 + $25 + $6 = $223.
You didn't beat the market. You shortened the clock on the capital that was doing the work, and the yield math rearranged itself in your favor.
The key things to now consider:
Your investment is still paying out 31 installments of $315.
Your line of credit is completely paid off and there is no additional cost.
The effective cost of the line of credit was $223/$10,000 = 2.23%. This is significantly lower than the "sticker rate" of 10%!
You have a balance of $1,352 = $1,575 - $223 in your account.
So you spent $8,648 = $10,000 - $1,352 of your own money to acquire an asset paying $9,765 over the next 31 months. And your $2,000/month is free to start cycle two.
You used a process called velocity of money to force the yield of your investment higher, lower your cost of borrowing. And now you can compound on top.
Over time this creates a massive escalation of your buying power for investments!
Where this strategy breaks
No investing strategy comes without risks, and the same is true for this one. Key aspects that will influence returns include:
Cost and access to the line of credit. Banks can change the interest and even close out accounts.
Performance of the actual investments can vary and payments may stop. This part is the most critical in my opinion and I will share how I manage this risk in future issues.
Discipline. This strategy relies on long term discipline and active management.
As a reminder: this content is created for educational and entertainment purposes. This is not financial advice.
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Disclaimer: All material is provided for educational purposes only and does not guarantee any financial results. This is not financial, legal, or tax advice. I am not a financial professional. Results vary and are dependent on individual effort, timing and circumstances. There is no solicitation to invest.